For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.

Lord Grantham? Lady Mary? Had I wandered into the wrong century? No, Vanguard’s social media team was simply discussing the fifth season of Downton Abbey, a television series about servants, lords, and ladies in post-Edwardian England.

Downton Abbey traffics in high-stakes moral conflict; heartbreak and romance; titillating scandal and velvet-gloved blackmail. The drama also features what seem to be case studies from the curriculum for the Certified Financial Planner™ designation.

Indeed, the characters’ investment and estate-planning blunders have inspired a bull market in coverage by the financial press. (See The Wall Street Journal’s analysis of financial lessons from the show’s third season.)

Behavioral biases

What fascinates many investors, including my colleagues, is that these blunders reflect cognitive biases and personality traits that play a prominent role in contemporary investor behavior too. Downton Abbey illustrates both self-sabotaging biases and some of the traits that can counteract them.

Overconfidence

What if you were exceptionally confident, indeed overconfident, in your investment acumen? You might invest your entire fortune in a single stock. Maybe you’d invest it all in a Canadian railway, as Robert Crawley, Earl of Grantham, does. The railway goes bankrupt. The fortune disappears. The Crawleys must contemplate the sale of their beloved Downton Abbey.

In his overconfidence, Lord Grantham violates the second of Vanguard’s four principles for investing success: Develop a suitable asset allocation using broadly diversified funds. Diversification can’t guarantee against a loss, of course, but it can protect you from an unnecessarily catastrophic loss.

The 2008‒2009 financial crisis provided a similarly vivid lesson in the value of diversification. In 2008, the S&P 500 Index returned –37%. Ugly, but it could have been worse. Investors who held a big stake in the onetime blue chips listed in this table’s first column would have sustained Lord Grantham‒like losses.

The 10 worst and best stocks in the S&P 500 Index in 2008

Sources: FactSet and Vanguard.

Hyperbolic discounting

The scriptwriters are able to save Downton Abbey. Matthew Crawley, a distant cousin and the heir to the estate, inherits a fortune from the father of his first fiancé, who perished in the 1918 influenza epidemic. Matthew is now married to Lady Mary, Lord Grantham’s eldest daughter. He invests the inheritance in Downton Abbey and assumes responsibility for managing the estate.

Before learning that he had become Downton Abbey’s heir, Matthew worked as a lawyer. (Under the era’s property laws, Lord Grantham’s daughters couldn’t inherit the estate.) The experience gave him insight into the ways that society and the economy were changing. He developed the investment and planning skills to meet the needs of the moment while preparing for the demands of the future.

Lord Grantham hasn’t developed these skills. He displays a tendency toward hyperbolic discounting, spending extravagantly on the estate today at the expense of its long-term future. Matthew must restructure the estate’s operations. He must mean-variance-optimize the family’s portfolio of castles, cattle, and land—or something like that.

Propensity to plan

Matthew benefits from a propensity to plan, a trait that is associated with higher levels of wealth accumulation. But then he dies.

His widow, Lady Mary, is the designated representative of their infant son. She assumes control of the estate. She, too, benefits from a propensity to plan, as well as an interest in what Vanguard founder John C. Bogle calls the “eternal triangle” of investing: risk, reward, and costs. As she seeks to secure the Crawley family’s financial future, Lady Mary contemplates each of these dimensions and decides to invest in pig farming.

Advisor’s alpha

Lady Mary turns to her brother-in-law, Tom, for counsel, recognizing the value of good advice. She seems to have an intuitive understanding of Advisor’s alpha, the title of a research paper that Vanguard would write some 90 years later. The research demonstrates that good advisors can protect investors from the kinds of self-sabotaging behaviors—inadequate diversification, impulsive decision-making, a failure to plan—that bedevil Lord Grantham.

Incidentally, Vanguard research on retirement savers has found that women are more likely than men to seek advice. Compared with men, they are more likely to invest in professionally managed asset allocations such as managed accounts and target-date funds, a behavior associated with better outcomes.

Coming soon?

As the series unfolds, I’m hoping for a subplot about a revolution in low-cost investing that’s gathering momentum on the other side of the Atlantic. Or maybe we’ll meet a mysterious stranger who shows up in the servants’ quarters with an armful of prospectuses.

“The era of the working estate is coming to an end,” he’ll explain. “In the future, you will have greater opportunity, particularly if you emulate Daisy” (the stranger nods at the assistant cook) “and invest in your human capital through education. You’ll also have greater responsibility to provide for your own financial security. Might I interest you in a prospectus for a target-date mutual fund?”

Stay tuned.

Notes:

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

Investments in Target Retirement Funds are subject to the risks of their underlying funds. The year in the Fund name refers to the approximate year (the target date) when an investor in the Fund would retire and leave the work force. The Fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in the Target Retirement Fund is not guaranteed at any time, including on or after the target date.

Andy Clarke

Andy is a senior investment strategist in Vanguard Investment Strategy Group. Before joining Vanguard in 1997, he worked at Morningstar. During his tenure at Vanguard, Andy wrote "Wealth of Experience," an introduction to investing based on ordinary people's stories about what has—and hasn't—worked as they've tried to meet their financial goals. Andy holds a B.A. from Haverford College and an M.S. from West Chester University. He is a CFA® charterholder.

Comments

Richard G. | December 17, 2015 11:59 am

To Mr. Clarke another great article and I want you to know that I am replying to your literary piece AFTER the FED has raised the prime % yesterday. Guess what I am going to do with my portifolio-NOTHING. As a member of Vanguard I do not invest or react to the short term changes to the market and I certainly never will put all of my eggs in one basket.Granted i know that the change will affect everyone plus or minus but with a long term horizon I know Vanguard is going to keep on rewarding the stay the course folkes.Good Luck to All with your investments.

Paul D. | March 10, 2015 2:02 pm

Andy, I Immensely enjoyed both your blog and the WSJ’s analysis of the shows’ lessons on astute investment and estate planning. It seems that in this years episode, there is more acceptance by both the ‘Upstairs and Downstairs’ inhabitants of an inevitable need to change with the changing times.

One thing is for sure, nothing remains the same for ever. Just last week I was lamenting my own torment over the Fed’s pending interest rate increase relative to my bond fund in a posting to Joe Davis’ “Cheap Oil” blog. Then the WSJ had an article on Saturday about Bear Markets with an accompanying graphic that put everything into the proper perspective for me. As I see it now, all I really need to do is wait and take advantage of the opportunities that will undoubtedly arise.

Carl S. | March 7, 2015 6:54 pm

We will have to see if the series continues running until the year when John Bogle started the Vanguard 500 index fund (I think it was about 1976), and whether Lord Grantham (by then about 102 years old) will invest in it. Of course, at that age that would be another inappropriate investment decision, even for that one in that extraordinarily profitable fund!

The problem is that — unless the producers speed up the series chronologically — I’ll probably be dead myself, or at least tired of watching it, although I’m not yet (tired of watching it, that is).

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For more information about Vanguard funds, visit vanguard.com or call 877-662-7447 to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including the possible loss of the money you invest.